Last week, I wrote about some of the benefits of investing directly in individual stocks. However, it can be challenging to decide which stocks to invest in. Here are some tools that can help simplify that process.
Create Your Own Mutual Fund
I’ve written before about the Motif Investing site and how you can use it to quickly create low cost stock portfolios (you can purchase a “motif” of up to 30 stocks or ETFs for $9.95) around various themes and strategies with as little as $2k. A similar service is provided by Folio Investing, which also allows you to purchase a basket of stocks or ETFs (or even mutual funds) for $4 per security or $29 per month for unlimited trades. Both sites allow you to invest in pre-designed portfolios that you can customize or you can create your own. This makes it much easier to invest in individual stocks even if you have a small amount to invest. Just be sure that you’re properly diversified because many of these portfolios are very concentrated in certain sectors.
The “Magic Formula”
Yeah, I know it sounds kind of kooky but the “magic formula” is a stock-picking formula designed by hedge fund manager, academic, and author Joel Greenblatt that has results that could fairly be described as “magical.” Greenblatt claims the formula has historically produced annualized returns of about 30% a year and while independent back tests show lower returns, they all agree that the formula has beaten the market even after taxes and transaction costs, something very few money managers do. The formula is based on investing in 20-30 quality stocks that are selling at value prices, similar to the strategy used by Warren Buffett. You would hold them for at least a year and then update your holdings.
So how do you access the magic formula? The good news is that Greenblatt offers a list of stocks chosen by the formula for free on his website. You just specify whether you want 30 or 50 stocks and the minimum market capitalization and the site spits out a list of stocks that currently fit the criteria. You can then purchase them through the brokerage firm of your choice.
After just short of a year, compare your holdings to the current list and make any changes. If you’re selling a stock at a loss in a taxable account, sell it before you’ve held it for 12 months to generate a short term loss that you can use to reduce your ordinary income taxes. If you’re selling at a gain in a taxable account, wait at least 12 months so your sale will be taxed at the lower long term capital gains rate. Buy the new stocks. Rinse and repeat.
There is one more thing to note here. If you decide to use the Magic Formula, follow it exactly. Investors who have tried to deviate by screening out some of the stocks have seen significantly lower returns on average. After all, part of why it works is that it screens out some of the emotional biases that can cause us to avoid some of the stocks with the best values.
Follow Your Favorite Guru
Don’t trust a formula to pick your stocks? Another option is to follow the stock picks from some of the top investors in the world at GuruFocus. You can subscribe to see the picks of your favorite “gurus” and mimic them in your own account for $299 a year (going up to $349 on May 15). That’s still probably a lot cheaper than buying their mutual fund if you have more than $50k or so to invest.
As Warren Buffett recently pointed out, one of the main advantages that small investors have today is that it costs so much less to invest in individual stocks. With new tools like these, buying individual stocks also doesn’t mean you have to invest completely on your own or even that you need a large portfolio to be diversified. You just need to be able to think outside the mutual fund.